The Medium Run 14.02 Notes 1 March 17, 2014 1 These slides are NOT a substitute for chapters 6 to 9 of the book. They are meant to give you a more coincise and analytical presentation of the the Medium Run Model but many aspects of the model that are discussed in the book are not in these slides, and we shall assume you have read the book. 14.02 Notes () The Medium Run March 17, 2014 1 / 18 The Short Run 14.02 Notes () The Medium Run March 17, 2014 2 / 18 How bad is the assumption that prices don’t move? Not too bad in the short run: 4 to 6 quarters. © Pearson. All rights reserved. This content is excluded from our Creative Commons license. For more information, see http://ocw.mit.edu/help/faq-fair-use/. 14.02 Notes () The Medium Run March 17, 2014 3 / 18 The Medium Run Think about what happens when …rms respond to an increase in demand by increasing production Higher production will lead to higher employment Higher employment will lead to lower unemployment Lower unemployment will lead to higher wages Higher wages will increase production costs, leading …rms to raise prices Higher prices will lead workers to ask for higher wages Higher wages will lead to further increases in prices and so on ... So far we assumed P = 1 We now move away from this assumption To understand how the sequqnce of events described above happens we need to undertsand I how the labor market works: employm ! unempl ! wages I how …rms set prices given production costs 14.02 Notes () The Medium Run March 17, 2014 4 / 18 Population, Labor force, Employment and Unemployment in the US (2010) Population: 308.7 million Non institutionalized civilian population: 237.8 million I Out of the labor force: 84.0 million I Civilian labor force: 153.8 million F F 14.02 Notes Employment: 139 million Unemployed: 14.8 million () The Medium Run March 17, 2014 5 / 18 Labor market ‡ows: measurement The Current Population Survey (CPS), is a monthly sample survey of approximately 60,000 households. Each month, the CPS is administered to about 40.000 households that were also in the survey during the previous month. The other 20.000 consists of new households The month-to-month overlap allows the Bureau of Labor Statistics to track individuals who change labor force status from one month to the next Figure is in the public domain courtesy of the Bureau of Labor Statistics. 14.02 Notes () The Medium Run March 17, 2014 6 / 18 Labor market ‡ows Figure is in the public domain courtesy of the Bureau of Labor Statistics. 14.02 Notes () The Medium Run March 17, 2014 7 / 18 Labor market ‡ows Figure is in the public domain courtesy of the Bureau of Labor Statistics. 14.02 Notes () The Medium Run March 17, 2014 8 / 18 Average monthly worker ‡ows, 1996-2003 Courtesy of Steven J. Davis, R. Jason Faberman, John Haltiwanger, and the American Economic Association. Used with permission. 14.02 Notes () The Medium Run March 17, 2014 9 / 18 Job creation and job destruction over the cycle Courtesy of Steven J. Davis, R. Jason Faberman, John Haltiwanger, and the American Economic Association. Used with permission. 14.02 Notes () The Medium Run March 17, 2014 10 / 18 Hires, separations, quits and layo¤s over the cycle Figure is in the public domain courtesy of the Bureau of Labor Statistics. 14.02 Notes () The Medium Run March 17, 2014 11 / 18 Labor force participation in a boom and in a recession "Data Source: FRED, Federal Reserve Economic Data, Federal Reserve Bank of St. Louis: Civilian Labor Force Participation Rate; U.S. Department of Commerce: Bureau of Economic Analysis; accessed September 9, 2014." "Data Source: FRED, Federal Reserve Economic Data, Federal Reserve Bank of St. Louis: Civilian Labor Force Participation Rate; U.S. Department of Commerce: Bureau of Economic Analysis; http://research.stlouisfed.org; accessed September 9, 2014." 14.02 Notes () The Medium Run March 17, 2014 12 / 18 How are wages and prices set wage setting W = P e F (u, z ) Let’s assume for the time being P e = P , so that dividing by P we get the real wage W /P W = F (u, z ), P Fu 0, Fz 0 price setting: start from the production fct assuming only one factor, N and constant returns to scale, so that marginal cost is W Y =N P = (1 + m )W W 1 = P 1+m 14.02 Notes () The Medium Run March 17, 2014 13 / 18 Wages, prices and the "natural" rate of unemployment 14.02 Notes () The Medium Run March 17, 2014 14 / 18 An increase in the generosity of unemployment bene…ts 14.02 Notes () The Medium Run March 17, 2014 15 / 18 Higher competition (lower mark-ups) reduce the natural rate of u 14.02 Notes () The Medium Run March 17, 2014 16 / 18 Model 3: a macroeconomic model of the Medium Run Aggregate supply (for given P e ) I I wage determination W = P e F (u, z ) price determination P = (1 + m )W P = P e (1 + m )F (u, z ) Going from u to Y u= U L N = =1 L L N =1 L Y L Price setting (for given P e ) P = P e (1 + m )F (1 14.02 Notes () The Medium Run Y , z) L March 17, 2014 17 / 18 Model 3: a macroeconomic model of the Medium Run Aggregate demand M = YL(i ) P 14.02 Notes () The Medium Run March 17, 2014 18 / 18 MIT OpenCourseWare http://ocw.mit.edu 14.02 Principles of Macroeconomics Spring 2014 For information about citing these materials or our Terms of Use, visit: http://ocw.mit.edu/terms.